Closed Stores=Big Bonuses

14 of the 40 large companies seeking US bankruptcy protection during the C-19 coronavirus chaos awarded bonuses to executives within a month of filing their case.

Under a Y 2005 bankruptcy law, companies are banned, with few exceptions, from paying executives retention bonuses while in bankruptcy.

But the firms used a loophole by granting payouts before filing.

6 of the 14 companies that approved bonuses within a month of their filings cited business challenges executives faced during the medical emergency chaos to justify the compensation.

32 of the 45 companies Reuters examined approved or paid bonuses within 6 months of filing.

About 50% authorized payouts within 2 months, 8 companies, including JC Penney Co Inc (OTCPINK:JCPNQ) and Hertz Global Holdings Inc (NYSE:HTZ), approved bonuses 5 days before seeking bankruptcy protection.

Hi-Crush Inc, a supplier of sand for Oil & Gas fracking, paid executive bonuses 2 days before its 12 July filing.

JC Penney temporarily closed its 846 department stores and furlough about 78,000 of its 85,000 employees as the chaos spread, and approved nearly $10 -M in payouts just before its 15 May filing.

The company declined to comment for this story but said in an earlier statement that the bonuses aimed to retain a “talented management team” that had made progress on a turnaround before the virus chaos.

The other companies declined to comment or did not respond.

Luxury retailer Neiman Marcus Group (private) in March temporarily closed all of its 67 stores and in April furloughed more than 11,000 employees and paid about $8-M in bonuses to Key executives to stay aboard.

Neiman Marcus drew scrutiny this week on a plan it proposed after filing for bankruptcy to pay additional bonuses to executives.

The company declined to comment.

Whiting Petroleum Corp (NYSE:WLL) bestowed $14.6-M in extra compensation to executives days before its 1 April bankruptcy.

Shale oil pioneer Chesapeake Energy Corp awarded $25-M to executives and lower-level employees in May, 8 wks before filing its bankruptcy.

Reuters reviewed financial disclosures and court records from 45 companies that filed for bankruptcy between 11 March, the day the World Health Organization (WHO) declared COVID-19 a pandemic, and 15 July.

Using a database provided by BankruptcyData, a division of New Generation Research Inc, Reuters reviewed companies with publicly traded stock or debt and more than $50-M in liabilities.

In March, creditors sued former Toys ‘R’ Us executives and directors, accusing them of misdeeds that included paying management bonuses days before its 2017 bankruptcy. A lawyer for the executives and directors said the bonuses were justified, given the extra work and stress on management, and that Toys ‘R’ Us had hoped to remain in business after restructuring.

In June, congressional Democrats responded to the virus-induced wave of bankruptcies by introducing legislation that would strengthen creditors’ rights to claw back bonuses. The bill faces slim prospects in the Republican-controlled Senate.

Firms paying pre-bankruptcy bonuses know they would face scrutiny in court on compensation proposed after their filings. The trustees have no power to halt bonuses paid even days before a company’s bankruptcy filing allowing firms to “escape the transparency and court review.“

The Y 2005 legislation required executives and other corporate insiders to have a competing job offer in hand before receiving retention bonuses during bankruptcy, among other restrictions.

That forced failing firms to devise new ways to pay the bonuses, according to some restructuring experts.

After the Y 2008 financial crisis, companies often proposed bonuses in bankruptcy court, casting them as incentive plans with goals executives must meet.

Judges approved the plans, ruling that the performance benchmarks put the compensation beyond the purview of the restrictions on retention bonuses. The plans sparked objections from Justice Department monitors who called them retention bonuses in disguise, often with easy milestones.

Eventually, companies found they could avoid scrutiny altogether by approving bonuses before bankruptcy filings.

Companies argue the bonuses are crucial to retaining executives whose departures could torpedo their businesses, ultimately leaving less money for creditors and employees. Now, some companies are bolstering those arguments by contending that their business would not have cratered without the economic turmoil of the C-19 coronavirus chaos.

The pre-bankruptcy payouts are needed because stock awards are worthless and it would be impossible for executives to meet business targets that were created before the economic crisis.

The bonuses ensure stability in leadership that is needed to hold faltering operations together.

From our point of view: We believe that the 90-day rule for paying executive bonuses should be extended to minimally 1-yr before a bankruptcy filing.

Rewarding executives for bankruptcies who fell asleep at the switch is grossly unfair to creditors. It is highway robbery for poor performance.

But, it is a practice often unjustifiably done.

This is what the law allows, rightly or wrongly: executive bonuses are classified as preference creditors under the pre-existing debt condition where  creditors that are paid within the 90 days before a bankruptcy filing aka the “preference period” on account of a pre-existing debt should be held liable to return the payment as a preference but are often not. 

A defense to a claim of preference is that the payment was received in the ordinary course of business between the debtor and creditor. 

Executive bonuses should be earned based for above-average performance and Chapter 7 and 11 bankruptcy filings are not that. Any defense for allowing them is a compromise or should be automatically forfeit. They can be earned only when there are proven differences in the manner in which the parties in the bankruptcies did business during the preference period as compared to past practices.

This might  include changes in the debtor’s method and timing of making payments. Payments that are received in response to creditor pressure or otherwise are typically orchestrated by executives pre-bankruptcy filings as we all know.  

Economist Bruce WD Barren explains, “In 2005, the definition of the ordinary course of business defense should not have been allowed to insulate payments from recovery, only if they are made according to what is considered the ordinary course in the creditor’s industry. 

He notes, that reclassifying or allowing executive bonuses are not justifiable.

Bruce WD Barren, Chairman of The EMCO/ Hanover Group. 

Mr. Barren is a leading middle market turnaround expert in the corporate middle market in the US with more than 200 separate turnarounds during his 50-yr frame as an advisor or corporate executive that have created in excess of a billion dollars in annual payroll over a sustained period of time, and recognized as such by the US Congress.

Have a healthy weekend, Keep the Faith!

By Paul Ebeling on July 18, 2020